In a recent interview, Bill Tynkaluk, President of Leon Frazer, recommends investors get more defensive by focusing on stocks that pay good dividends that are likely to increase over time. Tynkaluk currently has his eye on Enbridge, TransCanada, Fortis, Emera, BCE, Rogers and Shoppers Drug Mart.
“We hope to make a little money on utilities such as Fortis, which has raised its dividend, and BCE, which is yielding 6%”. Tynkaluk also has his eye on railways “but not at these prices”.
“I don't think you should be taking too much risk in this market. I think most of the stocks are overvalued. They're considerably ahead of earnings. If the earnings are not there, market prices will fall. We're being very, very cautious.”
A defensive strategy works best when stock markets have run ahead of earnings. Buying inexpensive shares with good growth prospects and rising dividends is also a good long-term strategy.
Tynkaluk’s market outlook is dismal. “Multiples are huge. How much higher can earnings go? I think it's going to take three or four years before earnings catch up to these multiples. We're very cautious.”
Your Stock Price Doesn’t Matter
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Investors interested in Leon Frazer should look at the IA Clarington Canadian Conservative Equity Fund. Leon Frazer are Dividend Growth investors.
Top Holdings include:
- BCE
- TransCanada
- Bank of Nova Scotia
- Fortis
- Enbridge
- Goldcorp
- TD Bank
- TransAlta
- Emera
- Manitoba Telecom
How does one do a cash flow analysis of a utility? Can one be a bit more generous with regard to debt ratios etc.? I have heard lots of criticism of Fortis (and Emera and ATCO etc but especially Fortis) for debt and dividend coverage. Some of the following posts, which characterize Fortis as a company that is being "bled dry", are typical:
http://finance.google.com/group/google.finance.666209/topics?hl=en
But is this a fair assessment?
As far as estimating cash flow, I rely on the folks at CIBC World Markets.
CIBC is forecasting Fortis’ 2010 Free Cash Flow per share to be $2.02 per share compared to $1.85 per share in 2009. It is this number (FCF per share) that Fortis is able to pay dividends to common shareholders. Free Cash Flow is calculated as Operating Cash Flow minus Maintenance Capex for the year. Based on these numbers, the payout ratio for the 2010 dividend is estimated to be around 69%.
When analyzing utilities, you should be more generous in regards to debt levels given that these are very capital intensive businesses. A 70% dividend payout ratio is also OK.
The author highlights some good points on Fortis, particularly the high amount of Goodwill on the balance sheet:
Management is claiming that they have "adopted a strategy of profitable growth with earnings per share as the primary measure of performance." In other words the balance sheet and shareholder equity be damned. Examples: the company issued 9.2 million preferred shares in 2008 for a total of 14.2 million outstanding, 12 million of which are convertible into common shares. Common shares out are increasing at a rapid rate with 11.7 million new ones issued in Dec. 08. The company lists "Goodwill" as $1.575 billion in assets, or about 46% of total equity. Current liabilities (payable within one year) outstrip current assets by $547 million. Try paying that off with "Goodwill". Oh, I know... let's just sell some more shares. We can pay the dividend... for now. First quarter long term debt is up, to $5.286 billion from $4.884 billion 3 months ago. And about the vaunted focus on earnings, they are down to $1.52 per share from $4.25 in 2003. This company is being bled white by debt.
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